Evan from My Journey to Millions is a New York attorney who works as a support staff in a large financial planning firm, has a small Trust and Estates Practice and is the sole owner and author of My Journey to Millions.  His blog discusses estate planning, insurance planning and his personal struggle from a broke law school graduate to his dream of netting millions.  Check out his blog for more information, or better yet just subscribe to his feed.

Using Whole Life Insurance to Create a Pension Income Stream

Rather then discuss fees, expenses, mortality charges, IRR, etc. I am going to build a real example using a real illustration program from a AAA rated insurance company. I will then compare that option to various returns.

Let’s choose our variables:

• 50 Year old Male;
• Non-Smoker;
• I will use the  2nd highest health rating (not a beacon of health but not standard);
• Like a “real” pension we are going to pay into the system until retirement in this case 65 (Chose a product that stops premiums at 65 automatically);
• We are going to pay into the system $1,000/month; and
• Going to take an income stream from 70 to 85.

All these variables will change the whole model, I just made these up because if I had to venture a guess Mr. GoTo’s demographic is likely to be around these variables.  Why did I choose 70 as a starting age? Well the cash value is growing tax deferred so why not let it grow for as long as possible?

In Year 2011 $12,000 will buy just about $319,000 in death benefit which will grow (non-guaranteed) to over $420,000 of death benefit when the client is 65.

• Then from age 70 to to 85 you will be provided $27,200/year tax  free (through loans and switching at basis)
• At age 85 there will still be a death benefit of a little bit over $130,000

Is this method perfect? No.  There may be tax issues if the policy crashes, but neither is the standard 401(k) as we all learned, both young and old.  Imagine if you were the one trying to retire in 2002, or more recently 2007.  My firm saw an increase in the amount being deposited with the insurance company (above their premium) because it was their only account that increased in value.

Comparing Whole Life Insurance as a Pension Income vs. Investing

This strategy is not going to work if you are getting 12% return, or even 8%…but if you are 63 and are in 100% equities then I am sure Mr. Tough Money Love will have something to say to you.  (Editors Note: Yes I will!) So, lets use a 4% net return (so we can either assume your holding muni’s or netting 4% on your portfolio).

This is all without a death benefit to go along with it.  If I use 6% net (8%+ gross) then I can safely say that the investments will “win.”  This strategy, on the other hand is relying on a AAA rated Company that has been around longer than some states.

Disclaimer: While I am licensed to sell life insurance, I have never sold a single policy nor do I own any whole life insurance since The Wife and I have different priorities right now.  I hope to purchase a policy by the end of the year.

Does anyone have any experience with this strategy?

Mr. GoTo’s comments:

Most personal finance writers not connected with the insurance industry will tell you that term insurance is preferred over whole life insurance as a financial tool to protect dependents in the event of your premature death. I agree with that. Yet I like this post from Evan because it discusses alternative uses of cash value life insurance.

Keeping in mind that most of the money you take out of a cash value insurance policy is a return of your own premiums, it is a way to achieve tax deferred growth, or even “tax free income” if you are willing to periodically borrow from your cash value and not repay it. You have to be careful, however, of the potential tax consequences of dying with policy loans outstanding.

As Evan acknowledges, the net investment returns achievable from cash value life insurance can be inferior to the alternatives. Nevertheless, there are wealthy investors who use cash value life insurance for tax and estate planning when they run out of better options.  If you plan on being this wealthy and need death benefit protection, it can’t hurt to at least consider this “life insurance as pension” strategy now.

No related posts.

Yet another reason to be looking for new life insurance coverage is if you are still working and your retirement assets have shrunk so much as to place your spouse at risk should you die suddenly.

I prefer to look for at least the initial information about insurance and other financial products online. It is easier and less stressful than confronting and resisting a sales pitch from an eager life insurance salesperson.

Finding Life Insurance Cost Information Online

I am familiar with several online resources for obtaining premium quotes for life insurance policies.

iQuote is a site that is dedicated to term life insurance information and quotes. After entering some basic information about yourself, you can instantly receive up to five term life insurance quotes from top-rated carriers. There is no obligation or cost involved in obtaining the quotes. If you are interested in applying for coverage after seeing the quotes, you can request an application online as well. All of the iQuote policies are probably going to require full underwriting, including a medical exam.

There are some sites where you can apply for and instantly obtain up to $500k of term life insurance without a medical exam. One example is eLifePolicy.com where you can even pay for and print your new policy from the web. Just keep in mind that most of these sites are operated by only one carrier.

A second online source of cost information for term life insurance is TermLifeInsurance.com. The concept is similar to iQuote. One feature I liked about the Term Life Insurance is that it actually identifies all of the life insurance companies that provide premium quotes through the site.

A third site for low cost term life information is insure.com which has information about a wide variety of insurance policies. Just be prepared to be contacted by an agent if you request a quote online.

If you want to contact a life insurance agent in person, most experts will suggest that you find an independent agent that represents multiple companies. A convenient way to find an agent in your area is through the Independent Insurance Agents & Brokers of America.

Find Other Life Insurance Information Online

With all that has happened in our financial markets, it is more important than ever to investigate the financial health of an insurance company before purchasing a policy. There are two well-known sources of insurance company ratings, A.M. Best and Standard & Poor’s. Definitely check those ratings before writing the check.

Other ratings agencies include Fitch Ratings, Moody’s Investor Services, and Weiss Ratings

Finally, for more basic consumer information about life insurance in general, there are at least two good online resources. The first is the American Council of Life Insurers. The other is the Insurance Information Institute.

Please leave a comment with any other relevant online life insurance sites that you are aware of.

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So what strategies should baby boomers consider in working with existing life insurance policies and future life insurance needs?  These are the strategies I am looking at:

Allow Term Insurance Policies to Expire

When we began our family, it was agreed that I would be the primary wage earner while my wife did most of her work in the home.  When our children were younger, I purchased a twenty-year level term insurance policy with a large (seven figure) death benefit.  The purpose for this policy was to allow my wife to continue her family support role without major disruption in life style if I were to die young.  Also, the death benefit was intended to fund college educations for all three of our sons in case I wasn’t around to provide those funds.  Our youngest son will finish college in two years so our intention is to allow this term life policy to expire.  There really is no need to replace the policy benefit at this point.

Use Policy Dividends to Pay Premiums

We purchased hybrid term/whole life insurance policies on my wife and I when we were young and about to start our family.  We also bought these policies for each of our sons when they were born.  This probably was not the ideal financial planning strategy but we did it as a means of forced savings combined with death benefits.  We still own all of the policies.   A few years ago, the dividends paid by these policies had grown to the point where they could be used to pay almost all of the premiums on the policies, so we instructed the insurance company to pay the premiums that way.  The only premiums we pay now are on term policies, yet the cash value on the whole life policies continues to grow.

Allow Policy Cash Value to Grow Tax Free

One of the tax-planning benefits of a whole life insurance policy is that the cash value grows tax free.  The IRS considers policy dividends (which create the cash value) to be a return of the premiums you paid over the years.  Only if the total dividends paid exceed the premiums paid are you taxed, and then only on the difference.  The IRS does not require you to make that determination or pay any tax owed until the policy is surrendered.  I am almost certain that our cash value now substantially exceeds premiums paid.  For that reason, even though I plan on surrendering the policies at some point to get access to the cash value, I don’t want to do it unless it makes good tax sense.  What I will probably do is wait until I retire, then decide if and when I need to supplement other retirement income by liquidating other assets.  If I have a need to do that without adding to our tax burden, I will consider surrendering one or more of the whole life policies.  My tax rate should be lower at that time, although I am not certain of that.

Borrow Against the Cash Value

I may decide at some point that I want to keep at least one of the whole life policies in force for the death benefit.  On the other hand, I would prefer not to die with cash value in the policy because I will have lost it.  So what I might consider doing is borrowing against the cash value and probably not pay back what I borrowed.   You can usually do that as long as what you borrow plus interest does not exceed the cash remaining in the policy.  One of the important things you need to be careful about if you decide to borrow against life insurance cash value is phantom income.  In other words, if your loan balance equals your cash value, then you decide to cancel the policy, you will be taxed on the amount by which your loan proceeds exceeded the premiums you paid.  The problem with that scenario is that there won’t be any cash in the policy to pay the taxes.  You could have a large tax bill (at ordinary income tax rates) and no way to pay it.  The way to prevent that from happening is to keep paying on the policy until you die.  That may not be the best overall strategy for you, so think carefully before starting a program of borrowing your life insurance cash value.

Surrender and Convert to a Life Annuity

I don’t know yet whether this is possible, but I can see some advantage to converting the cash value in our existing whole life policies into a single premium, fixed annuity, paying lifetime income.  If that could be done without creating a taxable event on surrender, that would be ideal.   This is something I need to investigate.

These are the primary strategies I have been thinking about.  One of my good friends is an insurance professional, so I plan on speaking to him about other options, including the annuity option and possibly incorporating life insurance into our estate plan.  That is a discussion for another day.

Image credit: Vjeran Lisjak

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